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G. Chandrashekhar

Mumbai, June 14

There has been a smart rise in commodity prices virtually across the board in recent weeks. Market sentiment now is more optimistic than in the first quarter. Macroeconomic data are improving steadily and leading indicators have begun to suggest that the worst for the global downturn may be over.

The latest OECD leading indicators for April are a case in point. There is a pick up in lead indicators for industrial countries. China continues to be mover and shaker and supporter of global commodity prices covering energy, metals and agriculture.

International steel prices look like they are rallying as apparent steel consumption is showing signs of recovery in many markets. China of course is the major market to show a dramatic recovery in demand and production. In May, China produced 46.5 million tonnes of crude steel, the highest rate of production since June 2008.

It translates to an annualised rate of 547 mt. But even outside China, consumption is ticking up in major markets.

Ocean freight rates, a good indicator of economic activity, have firmed following a large scale movement of bulk goods such as iron ore and coal.

Currency factors and inflationary expectations too are playing a role. As is well known, a weaker dollar translates to higher price for commodities priced in dollars.

Market fundamentals are seen improving for crude. Recent outlook suggests demand decline has surely bottomed, inventory is not burdensome as the overhang has eased, imports into major emerging markets are robust and supply constraints are beginning to draw market attention. Relentless rise of crude to over $70 a barrel is proof enough.

Investors have been active in the commodity market. In many commodities, long positions are being built, suggesting the markets view that prices have an upside potential. Experts assert that around the world, pension funds, sovereign wealth funds and the like are making inroads into commodities to exercise the strong diversification benefits the asset class offers.

While general momentum is to the upside, caution should be the watchword, simply because prices of some commodities have risen far beyond what their market fundamentals would justify. Some correction may be inevitable. So, while choosing commodity positions a thorough research is necessary.

Clearly, currency seems to dictate the price direction of the yellow metal as negative correlation with the dollar is established. Towards the end of last week, gold came under pressure as the dollar gained against the euro which saw profit taking. Inflows into physically-backed exchange traded products have slowed.

On Friday, in London the PM Fix was at $937.25 an ounce, down over one per cent from the previous days 947.50/oz. Silver was only a shade lower at $15.07/oz (Friday AM Fix) versus $15.09/oz the previous day.

However, investors are still increasing their exposure to gold primarily through paper holdings. Speculative interest in Comex gold has risen for six consecutive weeks as tactical investors have increased their long positions - both on gross and net basis - to their highest levels since July last year.

Since April 21, long positions in Comex have risen by 161 tonnes, while over the same period 58 tonnes of gold have been added to ETF holdings. Because gold has re-established its negative correlation with the dollar, a further weakness in the currency would help the metal gain upward traction.

However, for any reason, if the currency support fails, a new catalyst will be required to push prices higher. So, short-term correction cannot be ruled out. Gold jewellery demand is expected to resurface at price dips below $900/oz. So the downside seems to be limited. Over the medium-term, positive investor sentiment, expectation of a weaker dollar and build up of inflationary environment are all likely to boost the yellow metal.

Flow of positive data has led to further price gains for the base metals complex. But, the complex ended the strong week on a down note, following a strong rise in the value of the US dollar against the euro in the wake of weak euro-zone industrial production data.

Currently, extreme economic pessimism has given way to cautious optimism even as a sharp decline in global output appears to be over. This has surely attracted fresh buying interest in base metals. LME open interest has reached a record high.

The complex is expected to face volatility in the coming weeks. Prices could come in for correction as the rally has taken some commodities beyond the fundamentals. Aluminium and nickel face the biggest downside risk because of inventory overhang and restarted production in China.

Experts assert aluminium could hit a fresh cycle low in the months ahead, while nickel is likely to erase recent gains. The recent price strength in aluminium could be short-lived.

Chinese customs statistics show record copper imports. For the first five months of 2009, Chinese total copper imports hit 1.76 mt compared with 1.15 mt for the same period in 2008. However, imports are likely to slow after June as demand enters a seasonally weak period. So, until there is clear evidence of a slowdown in copper demand, prices could stay firm.

Copper, lead and zinc are likely to find support at lower levels given the more bullish medium-term outlook for demand, relative lower stock levels and less potential for a big ramp up in Chinese output. Copper is likely to find support at around $4,200/t, while for zinc buying is likely to emerge at around $1,200/t.

A steady upward movement in prices has continued, with the market reaching fresh set of new highs for the year. The global market sentiment has changed for the better. Macroeconomic data flows appear positive.

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